ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
Introduction
This overview highlights selected information in this Annual Report on Form 10-K and may not contain all of the information that is important to you. For a more complete understanding of trends, events,
commitments, uncertainties, liquidity, capital resources, and critical accounting estimates, you should carefully read this entire Annual Report on Form 10-K. For a discussion of changes in results of operations comparing the years ended December
31, 2020 and 2019, for the Company and its subsidiary, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with
the SEC on March 5, 2021.
Our subsidiary, First Northern Bank of Dixon, is a California state-chartered bank that derives most of its revenues from lending and deposit taking in the Sacramento Valley region of Northern
California. Interest rates, business conditions and customer confidence all affect our ability to generate revenues. In addition, the regulatory environment and competition can challenge our ability to generate those revenues.
Financial highlights for 2021 include:
The Company reported net income of $14.2 million for 2021, a 16.7% increase compared to net income of $12.2 million for 2020. Net income per common share for 2021 was $1.01, an increase of
17.4% compared to net income per common share of $0.86 for 2020. Net income per common share on a fully diluted basis was $1.00 for 2021, an increase of 17.7% compared to net income per common share on a fully diluted basis of $0.85 for 2020.
Net interest income totaled $46.3 million for 2021, a decrease of 2.4% from $47.4 million in 2020, primarily due to a decrease in interest income on loans and due from banks interest bearing
accounts, which was partially offset by a decrease in interest expense on deposits.
Reversal of provision for loan losses totaled $1.5 million in 2021, a decrease of 149.2% from a provision for loan losses of $3.1 million in 2020. The decrease was largely driven by the
decrease in specific reserves on impaired loans to one borrower, coupled with an overall decrease in qualitative factors resulting from an improvement in economic conditions.
Non-interest income totaled $7.9 million in 2021, an increase of 0.7% from $7.8 million in 2020. The increase was primarily due to increases in service charges on deposit accounts due to the
prior year waiver of overdraft/NSF fees in response to the COVID-19 pandemic and increases in debit card income and loan servicing income, which was partially offset by decreases in gain on sale of available-for-sale securities and gain on sale
of loans held-for-sale due to a decrease in volume of transactions.
Non-interest expenses totaled $36.2 million for 2021, up 2.0% from $35.5 million in 2020. The increase was primarily due to increases in data processing due to enhanced IT infrastructure and
the implementation of a digital lending platform for PPP loans and increases in loan collection expense and FDIC assessments. This was partially offset by a decrease in salaries and employee benefits, due to decreased staffing levels and a
decrease in occupancy expense, due to a lease termination in the 4th quarter of 2020.
The Company reported total assets of $1.90 billion as of December 31, 2021, up 14.7% from $1.66 billion as of December 31, 2020.
Investments increased to $632.2 million as of December 31, 2021, a 45.3% increase from $435.1 million as of December 31, 2020. U.S. Treasury securities totaled $86.2 million as of December
31, 2021, up 121.7% from $38.9 million as of December 31, 2020; securities of U.S. government agencies and corporations totaled $102.6 million, down 3.7% from $106.5 million as of December 31, 2020; obligations of state and political
subdivisions totaled $46.0 million, up 39.8% from $32.9 million as of December 31, 2020; collateralized mortgage obligations totaled $135.6 million, up 84.7% from $73.5 million as of December 31, 2020; and mortgage-backed securities totaled
$261.8 million, up 42.8% from $183.3 million as of December 31, 2020.
Loans (including loans held-for-sale), net of allowance, decreased to $853.8 million as of December 31, 2021, a 3.5% decrease from $885.0 million as of December 31, 2020. Commercial loans
totaled $135.9 million as of December 31, 2021, down 46.9% from $255.9 million as of December 31, 2020; commercial real estate loans were $526.9 million, up 16.0% from $454.1 million as of December 31, 2020; agriculture loans were $107.2 million,
up 12.8% from $95.0 million as of December 31, 2020; residential mortgage loans were $76.2 million, up 18.1% from $64.5 million as of December 31, 2020; residential construction loans were $4.5 million, up 6.1% from $4.2 million as of December
31, 2020; and consumer loans totaled $17.2 million, down 11.3% from $19.5 million as of December 31, 2020.
Deposits increased to $1.73 billion as of December 31, 2021, a 16.9% increase from $1.48 billion as of December 31, 2020.
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FHLB advances totaled $0 and $5.0 million as of December 31, 2021 and December 31, 2020, respectively. This advance was a short-term borrowing with a 0% interest rate that was received in 2020
through the FHLB’s COVID-19 Relief and Recovery Advances Program and matured in the second quarter of 2021.
Stockholders’ equity increased to $150.9 million as of December 31, 2021, a 0.2% increase from $150.7 million as of December 31, 2020.
Recent Developments Related to COVID-19
The coronavirus pandemic and the governmental actions in response to the pandemic, continue to have had an impact on our business. Our commercial real estate loan portfolio exposure to industries most affected by
the stay-at-home order and subsequent limitations on business activities included 11.3% to retail properties and business; 1.5% to restaurants; and 0.9% to the hospitality/hotel sector at December 31, 2021. Loans to these customers are generally
secured by real estate with moderate loan-to-value ratios and further supported by guarantors.
In January 2021, the SBA reopened the PPP with an initial deadline of March 31, 2021. On March 30, 2021, President Biden signed the PPP Extension Act of 2021 into law extending the PPP from March 31, 2021, to June
30, 2021. However, the SBA did not accept new lender applications for first draw or second draw PPP loans submitted after May 31, 2021. During this extension of the PPP, the Bank approved approximately 1,030 applications for loans covering
approximately $115 million in funding. These PPP loan originations resulted in approximately $5.4 million in processing fees from the SBA, which are being recognized as an adjustment to the effective yield over the loan’s life and fully
recognized in income upon repayment or forgiveness of the loan. PPP processing fees totaling approximately $4.7 million and $5.9 million were recognized in interest income for the years ended December 31, 2021 and 2020, respectively. This
includes the amortization of PPP processing fees received in 2020, which are also being recognized as an adjustment to the effective yield over the loan’s life and fully recognized in income upon repayment or forgiveness of the loan. The Bank had unearned PPP processing fees totaling $2.7 million and $1.9 million as of December 31, 2021 and December 31, 2020, respectively.
The Bank received $233 million and $80 million during 2021 and 2020, respectively, in payoffs and reimbursements on PPP loans from the SBA for the amounts forgiven pursuant to the terms of the PPP. The Bank had
PPP loans outstanding totaling $37 million and $155 million as of December 31, 2021 and December 31, 2020, respectively. The Company expects that a significant portion of these loans will be forgiven during 2022 under the terms of the PPP, as
borrowers satisfy the requirement of applying at least 60% of the loan proceeds to support their payroll expenses. Loans which do not qualify for the forgiveness will remain on the Bank’s books, subject to the SBA’s guarantee.
Critical Accounting Policies and Estimates
The Company’s discussion and analysis of its financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, income
and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for loan losses, other real estate owned, investments, and income
taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of
assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:
Allowance for Loan Losses
The Company believes the allowance for loan losses accounting policy is critical because the loan
portfolio represents the largest asset on the consolidated balance sheet, and there is significant judgment used in determining the adequacy of the allowance for loan losses. The Company
maintains an allowance for loan losses at an amount estimated to equal all credit losses incurred in our loan portfolio that are both probable and reasonable to estimate at a balance sheet date. Loan losses
are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is based on the Company’s periodic evaluation of the factors mentioned below, as well as
other pertinent factors.
The allowance for loan losses consists of a specifically allocated component and a collective or pooled component. The components of the allowance for loan losses represent estimates. The
specifically allocated component of the allowance for loan losses reflects expected losses resulting from specific analyses resulting in credit allocations for individual loans. The specific credit analyses are based on regular analyses of all
loans where the internal credit rating (risk rating) is at or below a predetermined classification. The Company manages risk ratings through the analysis of initial credit requests and ongoing examination of outstanding loans and delinquencies,
with particular attention to portfolio dynamics and loan mix. Determination of the risk rating involves significant management judgement. These specific analyses involve a high degree of judgment in estimating the amount of loss associated with
specific loans, including estimating the amount and timing of future cash flows and collateral values.
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A significant portion of the allowance for loan losses is measured on a collective (pooled) basis by loan type when similar risk characteristics exist. For loans evaluated collectively, the
allowance for loan losses is determined using historical losses adjusted for qualitative and environmental factors to reflect current conditions. The qualitative and environment factors used to adjust our historical loss rates by loan type
consist of the risks of the Company’s general lending activity, including risk of losses that are attributable to national or local economic or industry trends which have occurred but have yet been recognized in past loan charge-off history, and
risk of losses attributable to general attributes of the Company’s loan portfolio and credit administration. The most significant component of the factors used to estimate the allowance for loan losses are adjustments related to prevailing
economic and business conditions. The prevailing economic and business conditions factor is estimated based on a range of potential economic conditions and is applied at the pooled level based on various factors. This estimate is subject to
significant judgment and could potentially add $3.0 million based on existing loan balances, if not more, to the allowance for loan losses in more pessimistic business and economic conditions. Although the Company believes its process for
determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes
differ from Company estimates, additional provision for credit losses could be required that could adversely affect earnings or financial position in future periods.
Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the
loan agreement, including scheduled interest payments. For a loan that has been restructured in a troubled debt restructuring, the contractual terms of the loan agreement refer to the contractual terms specified by the original loan agreement,
not the contractual terms specified by the restructuring agreement. An impaired loan is measured based upon the present value of future cash flows discounted at the loan’s effective rate, the loan’s observable market price, or the fair value of
collateral if the loan is collateral dependent. If the measurement of the impaired loan is less than the recorded investment in the loan, an impairment is recognized by a charge to the allowance for loan losses.
Other-than-temporary Impairment in Debt Securities
Debt securities with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in
the case of fixed interest rate debt securities, from rising interest rates. At each consolidated financial statement date, management assesses each debt security in an unrealized loss position to determine if impaired debt securities are
temporarily impaired or if the impairment is other than temporary. This assessment includes consideration regarding the duration and severity of impairment, the credit quality of the issuer and a determination of whether the Company intends to
sell the security, or if it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. Other-than-temporary impairment is recognized in
earnings if one of the following conditions exists: 1) the Company’s intent is to sell the security; 2) it is more likely than not that the Company will be required to sell the security before the impairment is recovered; or 3) the Company does
not expect to recover its amortized cost basis. If, by contrast, the Company does not intend to sell the security and will not be required to sell the security prior to recovery of the amortized cost basis, the Company recognizes only the credit
loss component of other-than-temporary impairment in earnings. The credit loss component is calculated as the difference between the security’s amortized cost basis and the present value of its expected future cash flows. The remaining
difference between the security’s fair value and the present value of the future expected cash flows is deemed to be due to factors that are not credit related and is recognized in other comprehensive income.
Fair Value Measurements
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are
recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a non-recurring basis, such as loans held-for-sale, loans held-for-investment and certain other
assets. These non-recurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets. Transfers between levels of the fair value hierarchy are recognized on the actual date
of the event or circumstances that caused the transfer, which generally corresponds with the Company’s quarterly valuation process. For additional discussion, seeNote 13 to the Consolidated Financial
Statements in this Form 10-K.
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Share-Based Payment
The Company determines the fair value of stock options at grant date using the Black-Scholes-Merton pricing model that takes into account the stock price at the grant date, the exercise price,
the expected dividend yield, stock price volatility, and the risk-free interest rate over the expected life of the option. The Black-Scholes-Merton model requires the input of highly subjective assumptions including the expected life of the
stock-based award and stock price volatility. The estimates used in the model involve inherent uncertainties and the application of Management’s judgment. As a result, if other assumptions had been used, our recorded stock-based compensation
expense could have been materially different from that reflected in these financial statements. The fair value of non-vested restricted common shares generally equals the stock price at grant date. In addition, we estimate the expected
forfeiture rate and only recognize expense for those share-based awards expected to vest. If our actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different. For
additional discussion, see Note 15 to the Consolidated Financial Statements in this Form 10-K.
Accounting for Income Taxes
Income taxes reported in the consolidated financial statements are computed based on an asset and liability approach. We recognize the amount of taxes payable or refundable for the current
year, and deferred tax assets and liabilities for the expected future tax consequences that have been recognized in the financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between
the consolidated financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We record net deferred tax assets to the extent it is
more-likely-than-not that they will be realized. In evaluating our ability to recover the deferred tax assets, Management considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities,
projected future taxable income, tax planning strategies and recent financial operations. In projecting future taxable income, Management develops assumptions including the amount of future state and federal pretax operating income, the reversal
of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates being
used to manage the underlying business. The Company files consolidated federal and combined state income tax returns.
A “more-likely-than-not” recognition threshold must be met before a tax benefit can be recognized in the consolidated financial statements. For tax positions that meet the more-likely-than-not
threshold, an enterprise may recognize only the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with the taxing authority. To the extent tax authorities disagree with these tax
positions, our effective tax rates could be materially affected in the period of settlement with the taxing authorities. For additional discussion, see Note 18 to the Consolidated Financial Statements in this Form 10-K.
Mortgage Servicing Rights
Transfers and servicing of financial assets and extinguishments of liabilities are accounted for and reported based on consistent application of a financial-components approach that focuses on
control. Transfers of financial assets that are sales are distinguished from transfers that are secured borrowings. Retained servicing rights on loans sold are measured by allocating the previous carrying amount of the transferred assets
between the loans sold and retained interest, if any, based on their relative fair value at the date of transfer. Fair values are estimated using discounted cash flows based on a current market interest rate. The Company recognizes a gain and a
related asset for the fair value of the rights to service loans for others when loans are sold.
The recorded value of mortgage servicing rights is included in other assets on the Consolidated Balance Sheets initially at fair value, and is amortized in proportion to, and over the period
of, estimated net servicing revenues. The Company assesses capitalized mortgage servicing rights for impairment based upon the fair value of those rights at each reporting date. For purposes of measuring impairment, the rights are stratified
based upon the product type, term and interest rates. Fair value is determined by discounting estimated net future cash flows from mortgage servicing activities using discount rates that approximate current market rates and estimated prepayment
rates, among other assumptions. The amount of impairment recognized, if any, is the amount by which the capitalized mortgage servicing rights for a stratum exceeds their fair value. Impairment, if any, is recognized through a valuation
allowance for each individual stratum.
Impact of Recently Issued Accounting Standards
The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed by Congress and signed into law on March 27, 2020. Section 4013 of the CARES Act provides that a financial institution may elect to not
apply GAAP requirements to loan modifications related to the COVID-19 pandemic that would otherwise be categorized as a TDR and suspends the determination of loan modifications related to the COVID-19 pandemic from being treated as TDRs. The
relief from TDR guidance applies to modifications of loans that were not more than 30 days past due as of December 31, 2019, and modifications that occurred beginning on March 1, 2020 until the earlier of: sixty days after the date on which the
national emergency related to the COVID-19 outbreak is terminated or December 31, 2020. The suspension of TDR accounting and reporting guidance may not be applied to any adverse impact on the credit of a borrower that is not related to the
COVID-19 pandemic. In December 2020, the Consolidated Appropriations Act, 2021 was signed into law. Section 541 of this legislation, “Extension of
Temporary Relief From Troubled Debt Restructurings and Insurer Clarification,” extends Section 4013 of the CARES Act to the earlier of January 1, 2022 or 60 days after the termination of the national
emergency declaration relating to COVID-19. Future TDRs are indeterminable and will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and
duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.
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On April 3, 2020, the SEC Office of the Chief Accountant issued a public statement communicating that for eligible entities that elect to apply Section 4013 of the CARES Act, the SEC staff would not object that
this is in accordance with GAAP for the periods for which such elections are available. In June 2020, the American Institute of Certified Public Accountants published Q&A Section 2130.41 regarding a technical question regarding the
recognition of interest income on Section 4013 loans which provided multiple permitted policy elections regarding the recognition of interest on Section 4013 restructured loans.
The Bank has continued to actively assist its communities by providing temporary loan relief under Section 4013 of the CARES Act. This relief included loan modifications which include forbearance programs (both
full payment deferrals and interest only payments) to customers who have been negatively impacted by the pandemic. For loans that have been provided temporary full payment deferrals, the Bank has made a policy election to cease recognition of
interest income during the term of the payment deferrals (generally three to six months). Upon completion of the forbearance period, the foregone interest over the deferral period is capitalized as deferred interest and recognized as an
adjustment to the effective interest rate over the life of the loan using the effective yield method. Loans that were provided interest only payment relief will continue to accrue interest over the interest only period provided that the loans
continue to perform as agreed. This policy election does not impact the Bank’s existing policies regarding non-accrual determinations if reasonable doubt exists as to the full and timely collection of interest or principal or when a loan becomes
contractually past due by ninety days or more with respect to interest or principal regardless of whether a loan was modified under Section 4013 of the CARES Act. On March 22, 2020, the Federal bank regulatory agencies issued joint guidance
advising that the agencies have confirmed with the staff of the Financial Accounting Standards Board that short-term modifications due to COVID-19, made on a good faith basis to borrowers who were current prior to relief, are not TDRs. The CARES
Act also provided relief from TDR classification for certain COVID-19 loan modifications. The Bank elected not to classify modifications as TDRs that meet the criteria under either the CARES Act or the criteria specified by the regulatory
agencies as TDRs.
In March 2020, the FASB issued ASU 2020-02, Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842): Amendments to SEC Paragraphs Pursuant to
SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). This ASU adds an SEC paragraph pursuant to the issuance of SEC Staff Accounting
Bulletin No. 119 on loan losses to the FASB Codification Topic 326. This ASU also updates the SEC section of the Codification for the change in the effective date of Topic 842. This ASU was effective upon addition to the FASB Codification. The
Company adopted ASU 2016-02, Leases (Topic 842) on January 1, 2019. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326) is effective on January 1,
2023 for smaller reporting companies with less than $250 million in public float as defined in the SEC’s rules. The Company is a smaller reporting company. The Company will apply the amendment’s provisions as a cumulative-effect adjustment to
retained earnings at the beginning of the first period the amendment is effective. The Company has formed a team that is working on an implementation plan to adopt the amendment. The implementation plan will include developing policies,
procedures and internal controls over the model. The Company is also working with a software vendor to measure expected losses required by the amendment. The Company is currently evaluating the effects that the adoption of this amendment will
have on its consolidated financial statements and expects that the portfolio composition and economic conditions at the time of adoption will influence the accounting adjustment made at the time the amendment is adopted.
In March 2020, the FASB issued ASU 2020-03, Codification Improvements to Financial Instruments. The amendments in ASU 2020-03 make narrow-scope
improvements to various aspects of the financial instruments guidance, including the current expected credit losses (CECL) standard issued in 2016. The ASU is part of the FASB’s ongoing Codification improvement project aimed at clarifying
specific areas of accounting guidance to help avoid unintended application. The items addressed in that project generally are not expected to have a significant effect on current accounting practice or create a significant administrative cost for
most entities. Effective dates for each amendment vary. The Company does not expect the adoption of this update to have a significant impact on the Company’s consolidated financial statements.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848). This ASU provides temporary optional guidance to ease the potential
burden in accounting for reference rate reform. This ASU provides optional expedients and exceptions for contracts, hedging relationships, and other transactions that reference LIBOR or other reference rates expected to be discontinued because
of reference rate reform. This ASU was effective for all entities as of March 12, 2020 through December 31, 2022. As of January 1, 2022, the Company is no longer originating LIBOR based loans and are originating new loans using the Secured
Overnight Financing Rate (SOFR). For existing LIBOR based loans, the Company is monitoring the development and reporting of fallback indices. The Company does not expect this ASU to have a material impact on the Company’s consolidated financial
statements.
In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform (Topic 848): Scope. This ASU clarifies that certain optional expedients and
exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences
of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining,
discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is
subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes
March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company is in the process of evaluating the provisions of this ASU but does not expect it to have
a material impact on the Company’s consolidated financial statements.
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STATISTICAL INFORMATION AND DISCUSSION
The following statistical information and discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes included in Part II (Item 8) of this
Annual Report on Form 10-K.
The following tables present information regarding the consolidated average assets, liabilities and stockholders’ equity, the amounts of interest income from average earning assets and the
resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include non-performing loans. Interest income includes proceeds from loans on non-accrual status only to the extent cash payments
have been received and applied as interest income. Tax-exempt income is not shown on a tax equivalent basis.
Distribution of Assets, Liabilities and Stockholders’ Equity;
Interest Rates and Interest Differential
(Dollars in thousands)
Average Balance Percent Average Balance Percent Average Balance Percent
ASSETS
Other Real Estate Owned — — — — 840 0.1 %
LIABILITIES & STOCKHOLDERS’ EQUITY
Deposits:
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Net Interest Earnings
Average Balances, Yields and Rates
(Dollars in thousands)
Investment Securities:
Other Real Estate Owned — — 840
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Continuation of
Net Interest Earnings
Average Balances, Yields and Rates
(Dollars in thousands)
Interest-Bearing Deposits:
Interest-Bearing
Federal Home Loan Bank Advances 1,809 5,656 —
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Analysis of Changes
in Interest Income and Interest Expense
(Dollars in thousands)
Following is an analysis of changes in interest income and expense (dollars in thousands) for 2021 over 2020. Changes not solely due to interest rate or volume have been allocated
proportionately to interest rate and volume.
Volume Interest Rate Change
Increase (Decrease) in Interest Income:
Certificates of Deposit (106 ) (35 ) (141 )
Investment Securities - Non-taxable 151 (46 ) 105
Other Earning Assets 23 1 24
Increase (Decrease) in Interest Expense:
Deposits:
Interest-Bearing Transaction Deposits 54 (164 ) (110 )
Increase (Decrease) in Net Interest Income: $ 2,050 $ (3,166 ) $ (1,116 )
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INVESTMENT PORTFOLIO
Composition of Investment Securities
The mix of investment securities held by the Company at December 31 of the previous three fiscal years is as follows (dollars in thousands):
Investment securities available-for-sale (at fair value):
Securities of U.S. Government Agencies and Corporations 102,610 106,558
Obligations of State and Political Subdivisions 45,985 32,882
Maturities of Investment Securities
The following table summarizes the contractual maturity (dollars in thousands) and projected yields of the Company’s investment securities as of December 31, 2021. The yields on tax-exempt
securities are shown on a tax equivalent basis. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. In addition, factors
such as prepayments and interest rates may affect the yield on carrying value of mortgage related securities.
Period to Maturities
Within One Year After One But Within Five Years After Five But Within Ten Years
Amount Yield Amount Yield Amount Yield
Investment securities available-for-sale (at fair value):
After Ten Years Total
Amount Yield Amount Yield
Investment securities available-for-sale (at fair value):
U.S. Treasury Securities $ — — $ 86,211 0.94 %
Securities of U.S. Government Agencies and Corporations — — 102,610 0.89 %
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LOAN PORTFOLIO
Composition of Loans
The mix of loans, net of deferred origination fees and costs and allowance for loan losses and excluding loans held-for-sale, at December 31, for the previous three fiscal years is as follows
(dollars in thousands):
Balance Percent Balance Percent
Net deferred origination fees and costs (1,232 ) (1,968 )
As shown in the comparative figures for loan mix during 2021 and 2020, total loans increased as a result of increases in commercial real estate, agriculture, residential mortgage and
residential construction loans, which was partially offset by decreases in commercial and consumer loans. The decrease in commercial loans was primarily due to PPP loan forgiveness and payoffs totaling approximately $233 million during the year
ended December 31, 2021, which was partially offset by originations of PPP loans of $115 million during the year ended December 31, 2021.
Included in net deferred origination fees was approximately $2.7 million and $1.9 million in unearned PPP loan fees at December 31, 2021 and December 31, 2020, respectively. The Company
received a total of approximately $5.4 million and $7.8 million in processing fees from the SBA during 2021 and 2020, respectively. These fees are required to be recognized as an adjustment to the effective yield over the life of the loan. The
Company recognized approximately $4.7 million and $5.9 million of these processing fees during the years ended December 31, 2021 and December 31, 2020, respectively, which are included as a component of interest income on loans. The balance of
$2.7 million in deferred origination fees as of December 31, 2021 will be recognized over the remaining life of the PPP loans.
Commercial loans are primarily for financing the needs of a diverse group of businesses located in the Bank’s market areas. Commercial real estate loans generally fall into two categories,
owner-occupied and non-owner occupied. Real estate construction loans are generally for financing the construction of single-family residential homes for individuals and builders we believe are well-qualified. These loans are secured by real
estate and have short maturities. Residential mortgage loans, which are secured by real estate, include owner-occupied and non-owner occupied properties in the Bank’s market areas. Loans are considered agriculture loans when the primary source
of repayment is from the sale of an agricultural or agricultural-related product or service. Such loans are secured and/or unsecured to producers and processors of crops and livestock. The Bank also makes loans to individuals for investment
purposes.
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Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table presents the maturity distribution of our loan portfolio at December 31, 2021 (dollars in thousands) (excludes loans held-for-sale). The table also presents the portion of
loans that have fixed interest rates or variable interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index.
Loans with fixed interest rates:
Residential Construction 1,025 — — — 1,025
Loans with fixed interest rates:
Non-Accrual, Past Due, OREO and Restructured Loans
It is generally the Company’s policy to discontinue interest accruals once a loan is past due for a period of 90 days as to interest or principal payments. When a loan is placed on
non-accrual, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it
again becomes well secured and in the process of collection or all past due amounts have been collected and an appropriate period of performance has been demonstrated.
The following tables summarize the Company’s non-accrual loans by loan category (dollars in thousands), net of guarantees of the State of California and U.S. Government, including its agencies
and its government-sponsored agencies, at December 31, 2021 and 2020.
Gross Guaranteed Net Gross Guaranteed Net
Residential construction — — — — — —
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Non-accrual loans amounted to $10,197,000 at December 31, 2021, and were comprised of two commercial loans totaling $133,000, one commercial real estate loan totaling $555,000, three
agriculture loans totaling $8,712,000, one residential mortgage loan totaling $138,000 and four consumer loans totaling $659,000. Non-accrual loans amounted to $15,211,000 at December 31, 2020, and were comprised of four commercial loans
totaling $363,000, three commercial real estate loans totaling $4,875,000, three agriculture loans totaling $9,130,000, one residential mortgage loan totaling $153,000 and five consumer loans totaling $690,000.
If interest on non-accrual loans had been accrued, such interest income would have approximated $206,000 and $1,038,000 during the years ended December 31, 2021 and 2020, respectively. Income
actually recognized on nonaccrual loans at payoff approximated $516,000 and $71,000 for the years ended December 31, 2021 and 2020, respectively.
Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Non-performing
impaired loans are non-accrual loans and loans that are 90 days or more past due and still accruing. Total non-performing impaired loans at December 31, 2021 and 2020, consisting of loans on non-accrual status totaled $10,197,000 and
$15,211,000, respectively. A restructuring of a loan can constitute a troubled debt restructuring if the Company for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that it would not
otherwise consider. The Company had $10,103,000 and $2,325,000 in TDR loans as of December 31, 2021 and 2020, respectively. A loan that is restructured in a TDR is considered an impaired loan. Performing impaired loans, which solely consisted
of loans modified as TDRs, totaled $822,000 and $2,260,000 at December 31, 2021 and 2020, respectively. The Company expects to collect all principal and interest due from performing impaired loans. These loans are not on non-accrual status. No
assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans.
The Company had no loans 90 days past due and still accruing as of the periods ended December 31, 2021 and 2020.
As the following table illustrates, total non-performing assets, which consists of loans on non-accrual status, loans past due 90-days and still accruing and Other Real Estate Owned (“OREO”)
net of guarantees of the State of California and U.S. Government, including its agencies and its government-sponsored agencies, decreased $4,950,000, or 32.8%, to $10,164,000 from December 31, 2020 to December 31, 2021. Non-performing assets net
of guarantees represented 0.5% and 0.9% of total assets at December 31, 2021 and 2020, respectively. The Bank’s management believes that the $10,197,000 in non-accrual loans were appropriately reflected at their fair value at December 31, 2021.
However, no assurance can be given that the existing or any additional collateral will be sufficient to secure full recovery of the obligations owed under these loans.
Gross Guaranteed Net Gross Guaranteed Net
(dollars in thousands)
Loans 90 days past due and still accruing — — — — — —
Other real estate owned — — — — — —
Non-performing loans (net of guarantees) to total loans 1.2 % 1.7 %
Non-performing assets (net of guarantees) to total assets 0.5 % 0.9 %
OREO consists of property that the Company has acquired by deed in lieu of foreclosure or through foreclosure proceedings, and property that the Company does not hold title to but is in actual
control of, known as in-substance foreclosure. The estimated fair value of the property is determined prior to transferring the balance to OREO. The balance transferred to OREO is the estimated fair value of the property less estimated cost to
sell. Impairment may be deemed necessary to bring the book value of the loan equal to the appraised value. Appraisals or loan officer evaluations are then conducted periodically thereafter charging any additional impairment to the appropriate
expense account. The Company had no OREO as of the years ended December 31, 2021 and 2020.
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Potential Problem Loans
The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing
examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and loan mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly
based on realistic assessments of collectability and current collateral values and to maintain an adequate allowance for loan losses at all times. Asset quality reviews of loans and other non-performing assets are administered using credit risk
rating standards and criteria similar to those employed by state and federal banking regulatory agencies. The federal banking regulatory agencies utilize the following definitions for assets adversely classified for supervisory purposes:
“Substandard Assets: a substandard asset is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Assets so classified must have a well-defined weakness or weaknesses that
jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.” “Doubtful Assets: An asset classified doubtful has all the weaknesses
inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. OREO and loans
rated Substandard and Doubtful are deemed “classified assets.” This category, which includes both performing and non-performing assets, receives an elevated level of attention regarding collection.
Commercial loans, whether secured or unsecured, generally are made to support the short-term operations and other needs of small businesses. These loans are generally secured by the
receivables, equipment, and other real property of the business and are susceptible to the related risks described above. Problem commercial loans are generally identified by periodic review of financial information that may include financial
statements, tax returns, and payment history of the borrower. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal
payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become
necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at
origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Commercial real estate loans generally fall into two categories, owner-occupied and non-owner occupied. Loans secured by owner occupied real estate are primarily susceptible to changes in the
market conditions of the related business. This may be driven by, among other things, industry changes, geographic business changes, changes in the individual financial capacity of the business owner, general economic conditions, and changes in
business cycles. These same risks apply to commercial loans whether secured by equipment, receivables, or other personal property or unsecured. Problem commercial real estate loans are generally identified by periodic review of financial
information that may include financial statements, tax returns, payment history of the borrower, and site inspections. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment,
requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow,
repossession or foreclosure of the underlying collateral may become necessary. Losses on loans secured by owner-occupied real estate, equipment, or other personal property generally are dictated by the value of underlying collateral at the time
of default and liquidation of the collateral. When default is driven by issues related specifically to the business owner, collateral values tend to provide better repayment support and may result in little or no loss. Alternatively, when
default is driven by more general economic conditions, underlying collateral generally has devalued more and results in larger losses due to default. Loans secured by non-owner occupied real estate are primarily susceptible to risks associated
with swings in occupancy or vacancy and related shifts in lease rates, rental rates or room rates. Most often, these shifts are a result of changes in general economic or market conditions or overbuilding and resultant over-supply of space.
Losses are dependent on the value of underlying collateral at the time of default. Values are generally driven by these same factors and influenced by interest rates and required rates of return as well as changes in occupancy costs. Collateral
values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, sales invoices, or other appropriate means. Appropriate valuations are obtained at origination of the credit and
periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Agricultural loans, whether secured or unsecured, generally are made to producers and processors of crops and livestock. Repayment is primarily from the sale of an agricultural product or
service. Agricultural loans are generally secured by inventory, receivables, equipment, and other real property. Agricultural loans primarily are susceptible to changes in market demand for specific commodities. This may be exacerbated by,
among other things, industry changes, changes in the individual financial capacity of the business owner, general economic conditions and changes in business cycles, as well as changing weather conditions. Problem agricultural loans are
generally identified by periodic review of financial information that may include financial statements, tax returns, crop budgets, payment history, and crop inspections. Based on this information, the Company may decide to take any of several
courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based
on the borrower’s income and cash flow, repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent
third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market
conditions), once repayment is questionable, and the loan has been deemed classified.
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Residential mortgage loans, which are secured by real estate, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of
borrower’s cash flow to sustain payments, and shortfalls in collateral value. In general, non-payment is due to loss of employment and follows general economic trends in the marketplace, particularly the upward movement in the unemployment rate,
loss of collateral value, and demand shifts. Problem residential mortgage loans are generally identified via payment default. Based on this information, the Company may decide to take any of several courses of action, including demand for
repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow,
repossession or foreclosure of the underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or
other appropriate documentation. Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable,
and the loan has been deemed classified.
Construction loans, whether owner occupied or non-owner occupied residential development loans, are not only susceptible to the related risks described above but the added risks of construction
itself, including cost over-runs, mismanagement of the project, or lack of demand and market changes experienced at time of completion. Again, losses are primarily related to underlying collateral value and changes therein as described above.
Problem construction loans are generally identified by periodic review of financial information that may include financial statements, tax returns and payment history of the borrower. Based on this information, the Company may decide to take any
of several courses of action, including demand for repayment, requiring the borrower to provide a significant principal payment and/or additional collateral or requiring similar support from guarantors, or repossession or foreclosure of the
underlying collateral. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation. Appropriate valuations are
obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed classified.
Consumer loans, whether unsecured or secured, are primarily susceptible to four risks: non-payment due to diminished or lost income, over-extension of credit, a lack of borrower’s cash flow to
sustain payments, and shortfall in collateral value. In general, non-payment is due to loss of employment and will follow general economic trends in the marketplace, particularly the upward movements in the unemployment rate, loss of collateral
value, and demand shifts. Problem consumer loans are generally identified via payment default. Based on this information, the Company may decide to take any of several courses of action, including demand for repayment, requiring the borrower to
provide a significant principal payment and/or additional collateral or requiring similar support from guarantors. Notwithstanding, when repayment becomes unlikely based on the borrower’s income and cash flow, repossession or foreclosure of the
underlying collateral may become necessary. Collateral values may be determined by appraisals obtained through Bank-approved, licensed appraisers, qualified independent third parties, purchase invoices, or other appropriate documentation.
Appropriate valuations are obtained at origination of the credit and periodically thereafter (generally every 3-12 months depending on the collateral type and market conditions), once repayment is questionable, and the loan has been deemed
classified.
Once a loan becomes delinquent or repayment becomes questionable, a Company collection officer will address collateral shortfalls with the borrower and attempt to obtain additional collateral or a principal
payment. If this is not forthcoming and payment of principal and interest in accordance with the contractual terms of the loan agreement becomes unlikely, the Company will consider the loan to be impaired and will estimate its probable loss,
using the present value of future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. For collateral dependent loans, the
Company will utilize a recent valuation of the underlying collateral less estimated costs of sale, and charge-off the loan down to the estimated net realizable amount. Depending on the length of time until final collection, the Company may
periodically revalue the estimated loss and take additional charge-offs or specific reserves as warranted. Revaluations may occur as often as every 3-12 months depending on the underlying collateral and volatility of values. Final charge-offs or
recoveries are taken when the collateral is liquidated and the actual loss is confirmed. Unpaid balances on loans after or during collection and liquidation may also be pursued through legal action and attachment of wages or judgment liens on
the borrower’s other assets.
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Excluding the non-performing loans cited previously, loans totaling $4,687,000 and $11,878,000 were classified as substandard or doubtful loans, representing potential problem loans at December 31, 2021 and 2020,
respectively. In Management’s opinion, the potential loss related to these problem loans was sufficiently covered by the Bank’s existing loan loss reserve (Allowance for Loan Losses) at December 31, 2021 and 2020. The ratio of the Allowance for
Loan Losses to total loans at December 31, 2021 and 2020 was 1.61% and 1.73%, respectively.
SUMMARY OF LOAN LOSS EXPERIENCE
The Company’s allowance for credit losses is maintained at a level considered adequate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to
individual borrowers, as well as overall credit loss experience, the amount of past due, non-performing loans and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. A portion of the
allowance is specifically allocated to classified loans whose full collectability is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. In addition, loans with similar characteristics not usually criticized
using regulatory guidelines are analyzed based on the historical loss rates and delinquency trends, grouped by the number of days the payments on these loans are delinquent. Last, allocations are made to non-criticized and classified commercial
loans and residential real estate loans based on historical loss rates, and other statistical data. The remainder of the allowance is considered to be unallocated. The unallocated allowance is established to provide for probable losses that
have been incurred as of the reporting date but not reflected in the allocated allowance. It addresses additional qualitative factors consistent with Management’s analysis of the level of risks inherent in the loan portfolio, which are related
to the risks of the Company’s general lending activity. Included in the unallocated allowance is the risk of losses that are attributable to national or local economic or industry trends which have occurred but have yet been recognized in past
loan charge-off history (external factors). The external factors evaluated by the Company include: economic and business conditions, external competitive issues, and other factors. Also included in the unallocated allowance is the risk of
losses attributable to general attributes of the Company’s loan portfolio and credit administration (internal factors). The internal factors evaluated by the Company include: loan review system, adequacy of lending Management and staff, loan
policies and procedures, problem loan trends, concentrations of credit, and other factors. By their nature, these risks are not readily allocable to any specific loan category in a statistically meaningful manner and are difficult to quantify.
Management assigns a range of estimated risk to the qualitative risk factors described above based on Management’s judgment as to the level of risk and assigns a quantitative risk factor from the range of loss estimates to determine the
appropriate level of the unallocated portion of the allowance. Management considered the $13,952,000 allowance for credit losses to be adequate as a reserve against losses as of December 31, 2021.
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Analysis of the Allowance for Loan Losses
(Dollars in thousands)
Provision for Loan Losses (1,500 ) 3,050 —
Loans Charged-Off:
Commercial Real Estate — — —
Agriculture — — (98 )
Residential Mortgage (5 ) — —
Residential Construction — — —
Recoveries:
Commercial Real Estate 14 — —
Agriculture — — —
Residential Mortgage — — 74
Residential Construction — — 21
Net Recoveries (Charge-offs) 36 10 (466 )
Ratio of Net Recoveries (Charge-Offs)
During the Year to Average Loans
Outstanding During the Year 0.00 % 0.00 % (0.06 %)
Allowance for Loan Losses to Total Loans 1.61 % 1.73 % 1.58 %
Nonaccrual loans to Total Loans 1.2 % 1.7 % 0.1 %
Allowance for Loan Losses to Nonaccrual loans 136.8 % 101.3 % 1,067.9 %
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Allocation of the Allowance for Loan Losses
The Allowance for Loan Losses has been established as a general component available to absorb probable inherent losses throughout the loan
portfolio. The following table is an allocation of the Allowance for Loan Losses balance on the dates indicated (dollars in thousands):
Loan Type:
The Bank believes that any breakdown or allocation of the allowance into loan categories lends an appearance of exactness, which does not exist,
because the allowance is available for all loans. The allowance breakdown shown above is computed taking actual experience into consideration but should not be interpreted as an indication of the specific amount and allocation of actual
charge-offs that may ultimately occur.
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Deposits
The following table sets forth the average amount and the average rate paid on each of the listed deposit categories (dollars in thousands) during
the periods specified:
Deposit Type:
The following table sets forth by time remaining to maturity for the Bank’s time deposits over $250,000 (dollars in thousands) as of December 31, 2021:
Three months or less $ 1,400
Over three months through six months 1,940
Over six months through twelve months 3,253
Over twelve months 4,404
Short-Term Borrowings
Short-term borrowings totaled $0 and $5,000,000 as of December 31, 2021 and December 31, 2020, respectively. This borrowing consisted of an advance with the FHLB
through its COVID-19 Relief and Recovery Advances Program. The advance had a 0% interest rate and matured in the second quarter of 2021. The advance was secured under terms of a blanket collateral agreement by a pledge of FHLB stock and
certain other qualifying collateral such as commercial and mortgage loans. Average outstanding balances of short-term borrowings were $1,809,000 and $5,656,000 during 2021 and 2020, respectively. As of December 31, 2021, the Company had a remaining collateral borrowing capacity with the FHLB of $306,597,000 and, at such date, also had unsecured formal lines of credit totaling $122,000,000 with
correspondent banks.
The Company had no Federal Funds purchased during the years ended December 31, 2021 and 2020.
Long-Term Borrowings
The Company had no long-term borrowings at December 31, 2021 and 2020. There were no average outstanding balances of long-term borrowings during
2021 and 2020.
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Supplemental Compensation Plans
The Company and the Bank maintain an unfunded non-contributory defined benefit pension plan (“Salary Continuation Plan”) and related split dollar
plan for a select group of highly compensated employees. Eligibility to participate in the Salary Continuation Plan is limited to a select group of management or highly compensated employees of the Bank that are designated by the Board.
Additionally, the Company and the Bank adopted a supplemental executive retirement plan (“SERP”) in 2006. The SERP is intended to integrate the various forms of retirement payments offered to executives. There are currently three participants
in the SERP. At December 31, 2021, the accrued benefit liability was $6,581,000, of which $4,588,000 was recorded in interest payable and other liabilities and $1,993,000 was recorded in accumulated other comprehensive loss, net, in the
Consolidated Balance Sheets. At December 31, 2020, the accrued benefit liability was $7,127,000, of which $4,173,000 was recorded in interest payable and other liabilities and $2,954,000 was recorded in accumulated other comprehensive income,
net, in the Consolidated Balance Sheets.
The Company and the Bank maintain an unfunded non-contributory defined benefit pension plan (“Directors’ Retirement Plan”) and related split dollar
plan for the directors of the Bank. At December 31, 2021, the accrued benefit liability was $710,000, of which $692,000 was recorded in interest payable and other liabilities and $18,000 was recorded in accumulated other comprehensive loss,
net, in the Consolidated Balance Sheets. At December 31, 2020, the accrued benefit liability was $831,000, of which $757,000 was recorded in interest payable and other liabilities and $74,000 was recorded in accumulated other comprehensive
income, net, in the Consolidated Balance Sheets.
For additional information, see Note 17 to the Consolidated Financial Statements in this Form 10-K.
Overview
Year Ended December 31, 2021 Compared to Year Ended December 31, 2020
Net income for the year ended December 31, 2021, was $14.2 million, representing an increase of $2.0 million, or 16.7%, compared to net income of
$12.2 million for the year ended December 31, 2020. The increase in net income was principally attributable to a $4.6 million decrease in provision for loan loss and $0.6 million decrease in interest expense, which was partially offset by a
$1.7 million decrease in interest income, $0.7 million increase in non-interest expense and $0.7 million increase in provision for income taxes.
Total assets increased by $243.7 million, or 14.7%, to $1.90 billion as of December 31, 2021, compared to $1.66 billion at December 31, 2020. The
increase in total assets was primarily due to a $78.8 million increase in cash and cash equivalents, $197.1 million increase in investment securities and $2.1 million increase in interest receivable and other assets, which was partially offset
by a $3.7 million decrease in certificates of deposit and a $31.2 million decrease in net loans (including loans held-for-sale). Total deposits increased $250.1 million, or 16.9%, to $1.73 billion as of December 31, 2021, compared to $1.48
billion at December 31, 2020.
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Results of Operations
Net Interest Income
Net interest income is the excess of interest and fees earned on the Bank’s loans,
investment securities, federal funds sold and banker’s acceptances over the interest expense paid on deposits and other borrowed funds which are used to fund those assets. Net interest income is primarily affected by the yields and mix of
the Bank’s interest-earning assets and interest-bearing liabilities outstanding during the period. The $1,688,000 decrease in the Bank’s interest and dividend income in 2021 from 2020 was driven by decreased interest rates, which was
partially offset by increased volumes. The $1,362,000 decrease in the Bank’s interest income on loans was driven primarily by a decrease of $823,000 driven by a decline in average loans outstanding compounded by a decrease of
$539,000 due to decreasing interest rates. The $157,000 decrease in the Bank’s interest income on due from banks was driven primarily by a decrease of $444,000 due to decrease in average interest rates paid on excess reserves at the Federal
Reserve, partially offset by an increase of $287,000 driven by increased average due from bank balances outstanding. The $52,000 decrease in the Bank’s interest income on investment securities was driven primarily by a decrease of $2,862,000
due to decreasing interest rates, partially offset by an increase of $2,810,000 driven by increased investment securities balances outstanding. The $572,000 decrease in the Bank’s interest expense on deposits was
primarily driven by a $713,000 decrease due to decreasing interest rates, which was partially offset by a $141,000 increase driven by volume growth. See “Analysis of Changes in Interest Income and Interest Expense” set forth on page
40 of this Annual Report on Form 10-K for a discussion of the effects of interest rates and loan/deposit volume on net interest income.
The FRB influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. Our loan
portfolio is significantly affected by changes in the prime interest rate. In March 2020, the prime rate decreased 150 basis points to 3.25%, where it remained through December 31, 2021. In March 2020, the target range for the federal funds
rate decreased 150 basis points to 0% to 0.25%, where it remained through December 31, 2021. The decrease in the target range for the federal funds rate in March 2020 was largely an emergency measure by the FRB aimed at blunting the economic
impact of COVID-19. In late 2021 and continuing into 2022, the FRB has indicated an intention to raise interest rates in the coming year in light of inflationary trends in the economy. For additional information, see “During 2021, the U.S.
Economy Began to Reflect Relatively Rapid Rates of Increase in the Consumer Price Index and Other Economic Indices; a Prolonged Elevated Rate of Inflation Could Present Risks for the U.S. Banking Industry and Our Business”, in “Risk Factors”
(Item 1A) of this Annual Report on Form 10-K.
We are primarily funded by core deposits, with non-interest-bearing demand deposits historically being a significant source of funds. This
lower-cost funding base is expected to have a positive impact on our net interest income and net interest margin in a rising interest rate environment.
The nature and impact of future changes in interest rates and monetary policy on the business and earnings of the Company cannot be predicted. For
additional information, see “The Effects of Changes or Increases in, or Supervisory Enforcement of, Banking or Other Laws and Regulations or Governmental Fiscal or Monetary Policies Could Adversely Affect Us” and “During 2021, the U.S. Economy
Began to Reflect Relatively Rapid Rates of Increase in the Consumer Price Index and Other Economic Indices; a Prolonged Elevated Rate of Inflation Could Present Risks for the U.S. Banking Industry and Our Business” in “Risk Factors” (Item 1A)
of this Annual Report on Form 10-K.
Interest income on loans for 2021 was down 3.4% from 2020, decreasing from $40,569,000 to $39,207,000. The decrease in interest income on loans was primarily due to a decrease in PPP fee recognition, lower yields earned on newly originated loans and loans repricing at lower rates, which was partially offset by interest
recognized on CARES Act loan forbearances that were previously not accruing interest and the recovery of interest on nonaccrual loans to one borrower in 2021. In the second quarter of 2020, the Bank made a policy election to cease interest
recognition for loans provided temporary full payment deferrals during the term of the forbearance period (generally ranging from three to six months) under Section 4013 of the CARES Act. Upon completion of the payment forbearance period,
and resumption of performance under the original loan terms, the foregone interest is capitalized as deferred interest and recognized as a yield adjustment over the remaining loan term. Loans on interest-only plans continued to accrue
interest income given continued payment performance over the course of the forbearance period. A majority of loans completed their forbearance period during the fourth quarter of 2020 and the remaining loans completed their forbearance
period in 2021. Forbearance loans totaled $0 and $7.8 million at December 31, 2021 and December 31, 2020, respectively. The Bank recognized approximately $687,000 and $371,000 in deferred interest for the years ended December 31, 2021 and
2020, respectively.
Interest income on interest-bearing due from banks for 2021 was down 27.0% from 2020, decreasing from $582,000 to $425,000. The decrease in
interest income on interest-bearing due from banks was the result of an 18 basis point decrease in yield on interest-bearing due from banks, which was partially offset by a 71.8% increase in average balances of interest-bearing due from banks.
The decrease in yield was primarily due to the decrease in the effective federal funds rate as discussed above.
Interest income on certificates of deposit for 2021 was down 32.2% from 2020, decreasing from $438,000 to $297,000. The decrease in interest
income on certificates of deposit was the result of a 20 basis point decrease in yield coupled with a 25.8% decrease in average balances of certificates of deposit.
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Interest income on investment securities for 2021 was down 0.8% from 2020, decreasing from $6,904,000 to $6,852,000. The decrease in interest
income on investment securities was the result of a 67 basis point decrease in investment securities yields, which was partially offset by a 51.6% increase in average investment securities volume. The Bank deployed excess liquidity into the
investment portfolio over the course of 2021, although reinvestment rates were generally lower than existing yields in the portfolio, which decreased overall portfolio yields. Investment securities yields were 1.26% and 1.93% for 2021 and
2020, respectively.
Interest expense on deposits for 2021 was down 38.5% from 2020, decreasing from $1,484,000 to $912,000. The decrease in interest expense on
deposits was the result of a 9 basis point decrease in interest rates paid on interest-bearing deposits, which was partially offset by a 14.2% increase in average balances of interest-bearing deposits.
The mix of deposits for the previous three years was as follows (dollars in thousands):
Average Balance Percent Average Balance Percent Average Balance Percent
The Bank’s net interest margin (net interest income divided by average earning assets) was 2.62% in 2021 and 3.23% in 2020. The net interest
spread (average yield earned on interest-earning assets less the average rate paid on interest-bearing liabilities) was 2.58% in 2021 and 3.14% in 2020. The 56 basis point decrease in net spread in 2021 over 2020 was primarily due to an
overall decrease in interest rates on earning assets, coupled with an increase in average due from banks as a percentage of total average earning assets, which was partially offset by a decrease in interest rates on interest-bearing deposits.
Provision for Loan Losses
The provision for loan losses is established by charges to earnings based on management’s overall evaluation of the collectability of the loan
portfolio. Based on this evaluation, there was a reversal of provision for loan losses of $1,500,000 in 2021, compared to provision for loan losses of $3,050,000 in 2020. The reversal of provision for loan losses in 2021 was primarily due to
the decrease in specific reserves on impaired loans to one borrower, coupled with an overall decrease in qualitative factors resulting from an improvement in economic conditions. The
ratio of the Allowance for Loan Losses to total loans at December 31, 2021 was 1.61% compared to 1.73% at December 31, 2020. The ratio of the Allowance for Loan Losses to total non-accrual loans and loans past due 90 days or more, net of
guarantees was 137.3% at December 31, 2021, compared to 102.0% at December 31, 2020. The increase was primarily due to the decrease in nonaccrual loans, net of guarantees totaling $5.0 million.
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Non-Interest Income and Expenses
Non-interest income consisted primarily of service charges on deposit accounts, net gain on sale of available-for-sale securities, net realized
gains on loans held-for-sale, debit card income and other income. Non-interest income increased to $7,863,000 in 2021 from $7,809,000 in 2020, representing an increase of $54,000, or 0.7%. Service charges on deposit accounts increased
$285,000 in 2021 over 2020. The increase in service charges on deposit accounts was primarily due to the Bank’s decision in the prior year to waive overdraft/NSF fees for all
business and consumer customers. The decision to waive overdraft/NSF fees was in response to the COVID-19 pandemic and began in March 2020 and expired in August 2020. Net gains on sale of available-for-sale securities decreased
$517,000 in 2021 over 2020, primarily due to the sale of municipal, agency, and U.S. Treasury securities at a net loss. Net realized gains on loans held-for-sale decreased
$719,000 in 2021 over 2020. The decrease in gains on sales of loans held-for-sale was primarily due to a decrease in loan origination volumes compared to 2020. The Bank experienced an uptick in refinancing activity in 2020 due to the decline
in interest rates, which began to slow down in 2021. Debit card income increased $402,000 in 2021 over 2020, primarily due to volume of transactions. Other income increased $603,000 in 2021 over 2020. The increase in other income was
primarily due to an increase in loan servicing income, which was due to the reversal of impairment expense in 2021 on mortgage servicing rights asset.
Non-interest expenses consisted primarily of salaries and employee benefits, occupancy and equipment expense, data processing expense and other
expenses. Non-interest expenses increased to $36,201,000 in 2021 from $35,477,000 in 2020, representing an increase of $724,000, or 2.0%.
Following is an analysis of the increase or decrease in the components of non-interest expenses (dollars in thousands) during the periods
specified:
Amount Percent
Salaries and Employee Benefits $ (323 ) (1.4 %)
Occupancy and Equipment (210 ) (5.7 %)
Stationery and Supplies (34 ) (11.9 %)
Advertising (36 ) (8.6 %)
Directors Fees (21 ) (6.7 %)
OREO Expense and Impairment 1 (100.0 %)
The decrease in salaries and employee benefits in 2021 was primarily due to a 2.6%
decrease in regular salaries and a 24.4% increase in capitalization of loan origination costs, which was partially offset by a 19.4% increase in contingent compensation and a 14.1% increase in profit sharing expense. The decrease in regular
salaries expense was primarily due to a decrease in full-time equivalent employees. The increase in capitalization of loan origination costs was primarily due to increased originations of commercial real estate loans. The increase in
contingent compensation was primarily the result of improved financial performance. The increase in profit sharing expense was primarily due to the increase in income before tax compared to 2020. The decrease in occupancy and equipment
expense was primarily due to the lease termination of the former trust office in the fourth quarter of 2020 and a decrease in depreciation expense. The increase in data processing expenses was primarily due to costs associated with enhanced
IT infrastructure coupled with the implementation of a digital lending platform for PPP loans in the first quarter of 2021. The increase in other expenses was primarily due to increases in loan collection expenses and FDIC
assessments.
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Income Taxes
The provision for income taxes is primarily affected by the tax rate, the level of earnings before taxes and the level of tax-exempt income. In
2021, tax expense increased to $5,240,000 from $4,501,000 in 2020, due to an increase in income before taxes. Non-taxable municipal bond income was $603,000 and $498,000 for the years ended December 31, 2021 and 2020, respectively.
Liquidity
Liquidity is defined as the ability to generate cash at a reasonable cost to fulfill lending commitments and support asset growth, while satisfying
the withdrawal demands of deposit customers and any debt repayment requirements. The Bank’s principal sources of liquidity are core deposits and loan and investment payments and proceeds of sale and prepayments. Providing a secondary source
of liquidity is the available-for-sale investment portfolio. The Company held $632,213,000 in total investment securities at December 31, 2021. Under certain deposit, borrowing, and other arrangements, the Company must hold and pledge
investment securities as collateral. At December 31, 2021, such collateral requirements totaled approximately $39,695,000. As a smaller source of liquidity, the Bank can utilize existing credit arrangements.
The Company’s primary source of liquidity on a stand-alone basis is dividends from the Bank. As discussed in Part I (Item 1) of this Annual Report
on Form 10-K, dividends from the Bank are subject to regulatory and corporate law restrictions.
Liquidity risk can result from the mismatching of asset and liability cash flows, or from disruptions in the financial markets. The Bank experiences seasonal swings in deposits, which impact liquidity. Management has sought to address
these seasonal swings by scheduling investment maturities and developing seasonal credit arrangements with the Federal Home Loan Bank, Federal Reserve Bank and Federal Funds lines of credit with correspondent banks. In addition, the ability of
the Bank’s real estate department to originate and sell loans into the secondary market has provided another tool for the management of liquidity. As of December 31, 2021, the Company has not created any special purpose entities to securitize
assets or to obtain off-balance sheet funding.
The liquidity position of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations. Liquidity is
measured by various ratios, the most common of which is the ratio of net loans (including loans held-for-sale) to deposits. This ratio was 49.4% on December 31, 2021, and 59.9% on December 31, 2020. At December 31, 2021 and 2020, the Bank’s
ratio of core deposits to total assets was 90.4% and 88.4%, respectively. Core deposits include demand deposits, interest-bearing transaction deposits, savings and money market deposit accounts, and time deposits $250,000 or less. Core
deposits are important in maintaining a strong liquidity position as they represent a stable and relatively low-cost source of funds. Management believes that the Bank’s liquidity position was adequate in 2020. This is best illustrated by the
change in the Bank’s net non-core ratio, which explains the degree of reliance on non-core liabilities to fund long-term assets. At December 31, 2021, the Bank’s net core funding dependence ratio, the difference between non-core funds, time
deposits $250,000 or more and brokered time deposits under $250,000, and short-term investments to long-term assets, was (21.32)% as of December 31, 2021, and (18.64%) as of December 31, 2020. This ratio indicated at December 31, 2021, the
Bank did not significantly rely upon non-core deposits and borrowings to fund the Bank’s long-term assets, namely loans and investments. The Bank believes that by maintaining adequate volumes of short-term investments and implementing
competitive pricing strategies on deposits, it can ensure adequate liquidity to support future growth. The Bank also believes that its liquidity position remains strong to meet both present and future financial obligations and commitments,
events or uncertainties that have resulted or are reasonably likely to result in material changes with respect to the Bank’s liquidity.
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Commitments
The following table details the amounts and expected maturities of commitments as of December 31, 2021 (amounts in thousands):
Maturities by period
Commitments Total Less than 1 year 1-3 years 3-5 years More than 5 years
Commitments to extend credit
Residential Mortgage 249 — — 249 —
Commitments to sell loans 1,500 1,500 — — —
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit in the form of loans or through standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the
amounts recognized in the balance sheet. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. These loans have been sold to third parties without recourse,
subject to customary default, representations and warranties, recourse for breaches of the terms of the sales contracts and payment default recourse.
Financial instruments, whose contract amounts represent credit risk at December 31 of the indicated years, were as follows (amounts in thousands):
The Bank expects its liquidity position to remain strong in 2022, as the Bank expects to continue to grow into existing markets. Our liquidity
position is continuously monitored and adjustments are made to balance between sources and uses of funds as deemed appropriate. The Bank believes that it has the means to provide adequate liquidity for funding normal operations in 2022.
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Capital
The Company believes a strong capital position is essential to the Company’s continued growth and profitability. A solid capital base provides
depositors and shareholders with a margin of safety, while allowing the Company to take advantage of profitable opportunities, support future growth and provide protection against any unforeseen losses.
At December 31, 2021, stockholders’ equity totaled $150.9 million, an increase of $0.3 million from $150.7 million at December 31, 2020. The